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Strong ISM Services Index Eases Recession Fears: 5 Top Picks

Nalak Das

On Sep 5, the Institute for Supply Management (ISM) announced fresh figures for its service index for the month of August. Notably, the reading exceeded expectations and returned to the growth trajectory after two consecutive months of decline. The ISM Services index clearly reflects that the U.S. economy has sustained its momentum despite heightened trade conflict and global economic slowdown. Gains were broad-based and occurred in 16 out of the total 17 industries.

Service-oriented businesses remained strong in August, improving for 115 consecutive months. At this stage, it will be prudent to invest in stocks from the services sector with a favorable Zacks Rank and strong growth potential.

Services Index Rebounds in August

The ISM reported that its service index came in at 56.4% for the month of August, beating the consensus estimate of 54.2% and previous month’s reading of 53.7%. July’s reading was the lowest since August 2016. Notably, any reading above 50% indicates expansion of the services sector and a reading of above 55% reflects outstanding performance by the services sector.

A strong bunch of 16 industries expanded in May. The sole exception was Wholesale Trade. The Business Activity Index came in at 61.5%, and has now increased for 121 consecutive months. Additionally, the New Orders Index stood at 60.3% while the Employment Index came in at 53.1%. The ISM mentioned that the respondents are mostly optimistic about overall business conditions, but concerns remain about tariffs and employment resources.

The report became more important in light of the ISM manufacturing index for August, which revealed that the U.S. manufacturing contracted for the first time since August 2016. Investors were concerned that tepid data for both manufacturing and services sector will eventually lead to a recession. Notably, the services sector accounts for 70% of the U.S. GDP while the manufacturing sector commands around 12% of economic activities.  

Consumer Spending Remains Strong

In July, U.S. consumer spending increased significantly, indicating that worries about a near-term recession were probably overblown. Consumer expenditure increased 0.6% in July, fueled by households’ purchases of a variety of goods and services. The increase exceeded the consensus estimate of 0.5% and represents a solid improvement over June’s gain of 0.3%. After accounting for inflation, consumer spending experienced a 0.4% increase in July. This was a major improvement over the 0.2% increase experienced in June.

Meanwhile, on Sep 5, the Department of Labor reported that U.S. productivity (output per hour work) increased 2.3% in the second quarter of 2019, surpassing the consensus estimate of growth of 1.5%. Higher productivity will enable producers to raise workers’ pay without hiking the price of finished products. Consequently, higher wage will benefit workers, raising their standard of living.  

The above scenario clearly shows that U.S. consumer spending has remained robust so far in the third quarter after it rebounded in the second quarter.

Our Top Picks

Substantial expansion in the services sector is indicative of its continuing attractiveness as an investment option. This is why it makes good sense to add stocks from this sector to your portfolio. We have narrowed down our search to five such stocks each carrying a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

The chart below shows price performance of our five picks year to date.

Exantas Capital Corp. XAN is a real estate investment trust, primarily focusing on the origination, holding and management of commercial mortgage loans and commercial real estate-related debt investments in the United States. The company has expected earnings growth of 60.6% for the current year. The Zacks Consensus Estimate for the current year has improved by 6.1% over the last 60 days.

Chemed Corp. CHE provides hospice and palliative care services to patients through a network of physicians, registered nurses, home health aides, social workers, clergy, and volunteers in the United States. It operates through two segments, VITAS and Roto-Rooter. The company has expected earnings growth of 15.3% for the current year. The Zacks Consensus Estimate for the current year has improved by 7.8% over the last 60 days.

Viad Corp. VVI operates as an experiential services company in the United States, Canada, the United Kingdom, continental Europe, and the United Arab Emirates. It operates in two business groups, GES and Pursuit. The company has expected earnings growth of 15% for the current year. The Zacks Consensus Estimate for the current year has improved by 5.1% over the last 60 days.

Arbor Realty Trust Inc. ABR is a specialized real estate finance company investing in real estate-related bridge and mezzanine loans, preferred equity, mortgage-related securities and other real estate-related assets. The company has expected earnings growth of 9.9% for the current year. The Zacks Consensus Estimate for the current year has improved by 8.1% over the last 60 days.

DaVita Inc. DVA provides kidney dialysis services for patients suffering from chronic kidney failure or end-stage renal disease. It operates kidney dialysis centers and provides related lab services in outpatient dialysis centers. The company has expected earnings growth of 33.1% for the current year. The Zacks Consensus Estimate for the current year has improved by 12.3% over the last 60 days.

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